Fraud-on-the-Market Class Certification: Theory, Tolling and Materiality
Kelly, William J., Defense Counsel Journal
This article originally appeared in the March 2013 Class Actions and Multiparty Litigation Committee newsletter.
I. The Fraud On The Market and Halliburton
THE "fraud-on-the-market" theory under Rule 10b-5 of the Securities Exchange Act of 19341 is based on the premise that the price of actively traded securities (that is, "securities traded on efficient capital markets") reflects all relevant publicly available information. Consequently, the theory goes, misrepresentations defraud investors who trade on efficient markets, even regardless of whether the investors directly rely on the misrepresentations. This is because the misrepresentations unfairly affect the market price of securities.2 Requiring proof of direct reliance "would place an unnecessarily unrealistic evidentiary burden on [a] plaintiff who has traded on an impersonal market."3 Whether putative class representatives needed to prove "loss causation" (that is, that the material misrepresentation at issue caused the economic loss) to obtain class certification had presented a split of authority among the circuits.
On June 6, 2011, the Supreme Court held In Erica P. John Fund\ Inc. v. Halliburton Co.,4 that securities fraud class representatives alleging fraud-on-the-market need not prove loss causation at the certification stage in order to get the benefit of the fraud-on-the-market presumption of reliance. In its unanimous decision, the Supreme Court held that to invoke the fraud-on-the-market rebuttable presumption, plaintiffs must demonstrate that the misrepresentation was known publicly, that there was an efficient market for the stock, and that the transaction occurred between the misrepresentation and the corrective statement. The Supreme Court held that requiring an additional loss causation requirement at the certification stage would "contravene fundamental premises" of the theory. "The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation," Justice Roberts said, "has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory." Thus, the Court reasoned, "Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory."
Impact of Halliburton: Halliburton does not require plaintiffs to establish the materiality of alleged misstatements to invoke the fraud-on-the-market theory in support of class certification. To obtain certification, it is sufficient for plaintiffs to plead materiality and establish the elements of Rule 23. The tenants of loss causation are not dead in any trial on the merits of any litigation seeking to establish liability as between any plaintiff and any defendant. However, Justice Roberts' admonition that loss causation "has nothing to do with whether an investor relied on the misrepresentation in the first place" may provide plaintiffs a roadmap to circumnavigating a tight causational analysis at trial.
Proponents of securities fraud class actions hailed the Halliburton decision as a triumph of practicality, asserting that the Security Exchange Commission is not well equipped to be the sole policing agent to market fraud.5 To this group, the decision merely revived 13-year-old precedent on securities fraud law,6 and blocked the narrowing of class actions that allege manipulation of stock market prices. To proponents of the loss causation requirement, on the other hand, Halliburton may be seen as kicking the commonality can down the road, leading to a potentially over-inclusive class definition, an over-broad class notice, and the difficulties inherent in trying to "un-ring the bell" of improvidently overbroad certification.
Additionally, at the time of its ruling, some lawyers and commentators questioned the impact of Halliburton on other fraud consumer class theories invoking presumed reliance in support of class certification. …